More Affordable Student Loans

Many working families could not afford to pay for college without college loans. Although a college education usually pays for itself in higher earnings many times over, immediate liquidity problems may be a major obstacle for many families.^[12] As a result, an accessible and affordable student loan program is essential to college access.

In 1993, the student loan program needed serious reform.

• More than one borrower in five defaulted within two years of graduation.
• Subsidies for lenders and guaranty agencies (intermediaries between lenders and the Department of Education) created a large and unnecessary expense for taxpayers.
• Lenders and guaranty agencies faced financial disincentives to prevent defaults or spend taxpayer dollars prudently.
• Different lenders often had different paperwork, procedures, and schedules, causing confusion and administrative burdens for students and schools.
• Lenders and guaranty agencies often reported unreliable financial data to the government.

In 1993, President Clinton revolutionized college loans by championing the Direct Student Loan program. The Direct Loan system applies free-market principles effectively: It raises capital less expensively through U.S. Treasury bond sales and delivers and services loans through competitively awarded, performance-based contracts with top-quality private firms.

For students, reform means more accessible, cheaper loans. Students now can repay their loans as a share of their income and have saved $9 billion through lower interest rates and fees.

• New flexible loan repayments. By allowing graduates to repay their loans as a share of income, Direct Lending allows students to start college without fear of being unable to repay their loans. The "income-contingent" plan also enables college graduates to undertake teaching and other public service careers.
• Lower interest rates. Student loan borrowers since 1993 will save $100 annually for each $10,000 in outstanding loans—a total of $5 billion so far—due to reductions in the interest rate formula in 1993 and 1998. The Administration also championed the lower maximum rate paid by students, reduced from 10 percent to 8.25 percent, to protect them against high interest rates.
• Lower fees. Thanks to savings from the Direct Loan program, fees on direct and guaranteed loans were reduced from up to 8 percent of loan principal in 1993 to up to 4 percent today, saving students $4 billion so far. In 1999, in recognition of widespread discounts available on guaranteed student loans, the Administration reduced direct loan fees to 3 percent.
• Easier to receive and repay. Direct loans require less application paperwork and, unlike the guaranteed program, all borrowers have just one account with a single point of contact.
• Favorable refinancing terms. Loan consolidation allows students to better manage their debt and lock in favorable loan terms. A typical member of the Class of 2000 who consolidates before July 1, 2000, will save over $1,500 on $20,000 of debt due to today’s lower interest rates.

For taxpayers, the student loan reform means billions in savings.

• Direct loans are much cheaper for taxpayers. By eliminating subsidy payments to lenders, direct lending has saved over $4 billion over the past five years.
• Federal costs of guaranteed loans have also fallen. Federal subsidies for banks and guaranty agencies have also been pared down, saving taxpayers an additional $2 billion.
• The default rate has fallen for seven straight years, from 22.4 percent at the start of this Administration to a record-low 8.8 percent today.
• Collections on defaulted loans have tripled, from $1 billion to $3 billion, under this Administration.

For schools, student loan reform slashed administrative burdens.

• Over 1,200 schools chose to leave the guaranteed loan program and join Direct Lending during its first three years. Direct lending offers one set of procedures, fast and reliable delivery of funds, less paperwork, electronic loan processing, and a customer service emphasis.
• Schools in the guaranteed loan program have also benefited through competition. A new and strong competitor in one of the largest financial markets in the world, the Direct Loan program inspired lenders to improve their service.
• School satisfaction with the guaranteed loan programs has increased every year since 1994, according to independent surveys.
• A senior banking executive told a trade journal that "[Direct Loans] have introduced some ways of doing business and some delivery mechanisms that made the private enterprise wake up a little bit. To be perfectly honest, as a private enterprise we thought we were doing almost an A-plus job. When we stepped back a little bit, we saw some of the things the Department of Education was doing and we realized we weren't. . . . It's been relatively good for the industry, particularly for the recipients in terms of students and schools."^[13]
• A 1999 independent assessment concluded, "Virtually no one disputes that the operation of an alternative loan program has produced a competition that inspired innovation and service—to the benefit of all borrowers and schools."^[14]

By signing a tax deduction for student loan interest into law in 1997, President Clinton complemented these reforms. This legislation—which reinstated a provision that had been repealed in the 1980s—will, for example, provide $144 in tax relief to a college graduate earning $25,000 a year and struggling to repay her $12,000 debt. This year, President Clinton asked Congress to expand the student loan interest deduction because current law covers only the first 60 months of loan repayment.

In sum, there was little competition in the student loan program in 1993. The Direct Loan program gave students and schools a choice, injecting healthy competition into the marketplace. Students have saved $9 billion in interest and fees and enjoyed new tools to manage their debt, including income-contingent repayment. Taxpayers have saved an additional $6 billion. Today we have two leaner, more competitive, customer-focused programs.

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